Change of Policy on Overallotment Options
TO: All NASD Members and Other Interested Persons
The National Association of Securities Dealers, Inc. ("NASD" or "Association") is announcing a change in its policy with respect to overallotment options for firm commitment offerings. On August 4, 1983, the Securities and Exchange Commission ("SEC") approved an amendment to the Interpretation of the Board of Governors — Review of Corporate Financing under Article III, Section 1 of the Rules of Fair Practice (NASD Manual (CCH) para. 2151) ("Interpretation"). Effective immediately, the new policy changes the size of an overallotment option which is presumptively reasonable from ten to fifteen percent of the amount of securities being offered. Background information and an explanation of the new policy are set forth below.
The new provision amends the longstanding policy of the Association which established as presumptively unfair and unreasonable the granting to underwriters or related persons of an overallotment option of more than ten percent of the amount of securities in a public offering. The Association determined that this policy was no longer an appropriate response to market forces as they presently exist.
The Association's policy on overallotment options has not been previously codified into the Interpretation, although the policy has been consistently applied from the 1960's and has been periodically reviewed by the Corporate Financing Committee ("Committee"). The ten percent limitation had been retained based upon the belief that an underwriter should be able to measure demand for a new issue within a ten percent range. There was an additional concern that large over-allotment options can alter the underwriter's obligation such that a "firm commitment" offering becomes more akin to a "best efforts" undertaking.
Over the past several months, it has become apparent that the increased volatility of prices and trading volume in the securities markets has made it more difficult for underwriters to accurately judge demand or to achieve an orderly distribution of an issuer's securities. These problems are exacerbated by the increasingly large size of public offerings, especially initial public offerings. In view of these factors, the Committee determined that the ten percent policy should be reviewed to ascertain its viability under current market conditions.
In reviewing the ten percent policy, the need for any Association regulation of overallotment options was considered. It was concluded that it is in issuers' and investors' interest for the Association to place reasonable restrictions upon overallotment options. Such restrictions assist in assuring that the size of an offering does not become distorted from that originally described to investors and help to achieve a more orderly distribution. Recognizing that price and volume volatility has changed dramatically since the adoption of the ten percent policy, it was concluded that greater flexibility in determining the size of an offering may be necessary for some offerings in the present market environment.
Giving effect to all of these considerations, it was concluded that the Association's policy on overallotment options should be revised and that overallotment options which do not exceed fifteen percent of the offering should be presumed to be reasonable. The Association anticipates, however, that the size of the overallotment option in any offering will be determined by negotiation between the issuer and underwriter, and that many offerings will be made with overallotment options of less than fifteen percent.
New Policy on Overallotment Options
Effective August 4, 1983, the Association's policy on overallotment options is changed and any arrangements for such an option in a registration statement filed after that date will be presumed to be fair and reasonable if the amount of the option does not exceed fifteen percent of the amount of securities being offered. The policy applies to any public offering, including an initial public offering, which is underwritten on a "firm commitment" basis and in which any NASD member participates.
The amount of an overallotment option is calculated by the Association as a percentage of the amount of securities being offered. Securities received as underwriting compensation and securities to be issued as part of the option are not included in calculating the option.
A copy of the text of the new provision, which will be added to the Interpretation, is attached.
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Questions regarding this notice may be directed to Dennis C. Hensley, Harry E. Tutwiler or Daniel P. Weitzel of the Corporate Financing Department at (202) 728-8258.
Gordon S. Macklin
When proposed in connection with the distribution of a public offering of securities on a "firm commitment" basis, any option to be granted to an underwriter or related person for an overallotment of more than fifteen percent of the amount of securities being offered (computed excluding any securities offered pursuant to the option) shall be presumed to be unfair and unreasonable.